Crude Politics to Keep Oil Price Rising

Andrew Ellson, Times UK:

This week the price of a barrel of oil surged towards $70 a barrel, up more than 65 per cent on the start to the year and near the inflation-adjusted price last seen in 1980, shortly after the Iranian revolution.

Although the latest price spike was triggered by storm worries in the Gulf of Mexico and a bigger-than-expected drop in American supplies of petrol, analysts agree that increasing demand is the principal price driver.

America is showing no let up in its demand for oil while the rapidly expanding economies of India and China are importing ever-larger quantities to meet their demands of growth.

The International Energy Agency estimates that demand for oil will increase to nearly 84 million barrels a day by the end of this year and will reach almost 87 million barrels a day by the end of next year.

But rising demand does not tell the whole story – geopolitical factors are also contributing and could conspire to send prices spiralling towards the "super spike" of $100 a barrel which some analysts warned against earlier this year. And just like in 1979, one country is causing particular concern: Iran. READ MORE

In 1979, Islamic leaders swept to power overthrowing the monarchy. Then, the uncertainty over Iran’s oil supplies sent prices rocketing.

Today, it is not the threat of another revolution but the potential consequences of Iran’s pursuit of nuclear weapons that is agitating world oil markets.

Iran has always claimed that its nuclear ambitions do not go further than developing atomic energy, but growing Persian nationalism and the revelation that the country had been secretly developing a nuclear programme over the past 20 years has increased international suspicions and led to threats of economic sanctions.

Observers question why the country with the fourth largest reserves of oil in the world would need a nuclear energy programme.

The international community, particularly America, seems determined to stop Iran, an Islamic state well within ballistic missile range of Israel, from gaining nuclear weapons. The similarities with the stand-off which developed between the US and Iraq are clear, and the use of military force cannot be ruled out.

Analysts say this uncertainty over the outcome of the nuclear dispute is already adding a considerable "risk premium" to the cost of oil and things are likely to get worse before they get better.

In a research briefing, Jean-Pierre Hellebuyck, the chief investment strategist of AXA, noted that after Saudi Arabia, Iran is the second largest producer of oil within Opec, with an output of 4 million barrels a day.

"In the current market, with supply running perilously close to the maximum that producers can provide, losing Iran’s contribution would really come as a shock, generating a situation of unmanageable chaos," he said.

Another analyst told Times Online that the price of oil could spike to $100 a barrel should the threat of conflict with Iran escalate significantly.

"It is very difficult to quantify the premium for geopolitical risk, but inventory-adjusted demand would suggest a price of around $55 to $60 a barrel. With prices almost hitting $70, you can see how nervous the market is," said the analyst, who asked not to be identified.

"The problem is that there is so little spare production capacity that any increase in the risk of disruption to supply leads to a large spike in the price. This effect can sometimes be amplified by the flows of speculative money.

"It is not like ten or even five years ago when, if something went wrong, the Saudis could just step in and increase production to save the day."

Saudi Arabia is still the world's largest oil exporter but these days it is producing at near capacity. The country's security situation is also a worry for world oil markets with terrorists regularly attacking oil refineries in order to disrupt supply.

Islamic extremists have also been trying to forment discontent with the ruling royal family in Saudi, so the recent death of King Fahd sent oil prices soaring, despite the fact that there was unlikely to be any change in Saudi policy with the succession. Any sign of political instability in Saudi Arabia makes oil dealers very anxious and the result is higher prices.

Nigeria and Venezuela, the fourth and fifth largest Opec producers respectively, also have their own problems.

The political situation in Venezuela is volatile with refineries and shipping often crippled by industrial action, while Nigerian output has previously been disrupted by anti-government rebels hoping to focus the world’s attention on their grievances.

Then there is the ongoing insurgency in Iraq, which does not look anywhere near resolution.

Mr Hellebuyck says that with global politics in a state of turmoil, he can’t see oil prices falling significantly before 2006.

"Regardless of how things evolve, tensions will remain high, and we don’t see how the risk premium on the oil price can contract to any significant degree."

It appears that until demand falls or supply expands significantly oil prices will remain at the mercy of politics.